Wednesday, October 5, 2011

"Forecasting the Market: A Thought Experiment Revisited"

From dShort:
At the beginning of October with 99% of Q2 earnings reported, here is the latest update of my ongoing "thought experiment" for forecasting the S&P 500 price based on earnings fundamentals.

The chart below is based on the latest trailing twelve-month earnings (TTM) data published on the Standard & Poor's website as of September 30. The numbers are from the spreadsheet maintained by senior analyst Howard Silverblatt. See dshort's monthly valuation update for instructions on downloading the spreadsheet.

Here are the key assumptions in the calculations:
  • The 10-year average of nominal TTM earnings is 50.41 at the end of 2010, rising to 53.67 by the end of the year.
  • The average nominal cyclical P/E10 is currently 18.10.
  • The S&P 500 historic prices used in the calculations are monthly averages of daily closes.
  • Standard & Poor's estimates of TTM earnings for Q3 2011 through Q2 2012 are
    $87.98, $89.28, $92.11, and $93.86 (as of the September 30 spreadsheet).
  • The months between the quarterly earnings estimates are linear interpolations.
The blue line represents Standard & Poor's TTM forecast earnings by month multiplied by the historical nominal 10-year P/E ratio. At 2011 year-end earnings of 89.28 and an average nominal P/E of 18.10, we would see the S&P 500 at 1616. At this level, the nominal P/E10 would be 30.30, and the index would be 66.3% above a hypothetical price multiple of the extrapolated 10-year earnings average....MORE (pessimistic view)